Economic Aspects of Power Generation | Power Systems - Electrical Engineering (EE) PDF Download

 Page 1


  
 
Economics of Power Generation 
The art of determining the per unit (i.e., one kWh) cost of production of electrical energy is known as 
economics of power generation. 
     The economics of power generation has assumed a great importance in this fast developing power 
plant engineering. A consumer will use electric power only if it is supplied at reasonable rate. Therefore, 
power engineers have to find convenient methods to produce electric power as cheap as possible so that 
consumers are tempted to use electrical methods. Before passing on to the subject further, it is desirable 
that the readers get themselves acquainted with the following terms much used 
in the economics of power generation : 
      (i) Interest. The cost of use of money is known as interest.  A power station is constructed by investing 
a huge capital. This money is generally borrowed from banks or other financial institutions and the supply 
company has to pay the annual interest on 
this amount. Even if company has spent out of its reserve funds, the interest must be still allowed for, 
since this amount could have earned interest if deposited in a bank. Therefore, while calculating the cost 
of production of electrical energy, the interest payable on the capital investment must be included. The 
rate of interest depends upon market position and other factors, and may vary from 4% to 8% per annum. 
     (ii) Depreciation. The decrease in the value of the power plant equipment and building due to constant 
use is known as depreciation. If the power station equipment were to last for ever, then interest on the 
capital investment would have been the only charge to be made. However, in actual practice, every 
power station has a useful life ranging from fifty to sixty years. From the time the power station is 
installed, its equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in 
the value of the plant. This reduction in the value of plant every year is known as annual depreciation. 
Due to depreciation, the plant has to be replaced by the new one after its useful life. Therefore, suitable 
amount must be set aside every year so that by the time the plant retires, the collected amount by way of 
depreciation equals the cost of replacement. It becomes obvious that while determining the cost of 
production, annual depreciation charges must be included.  
Cost of Electrical Energy 
The total cost of electrical energy generated can be divided into three parts, namely; 
(i) Fixed cost ; 
(ii) Semi-fixed cost ; 
(iii) Running or operating cost. 
       (i) Fixed cost. It is the cost which is independent of maximum demand and units generated. The fixed 
cost is due to the annual cost of central organization, interest on capital cost of land and salaries of high 
Page 2


  
 
Economics of Power Generation 
The art of determining the per unit (i.e., one kWh) cost of production of electrical energy is known as 
economics of power generation. 
     The economics of power generation has assumed a great importance in this fast developing power 
plant engineering. A consumer will use electric power only if it is supplied at reasonable rate. Therefore, 
power engineers have to find convenient methods to produce electric power as cheap as possible so that 
consumers are tempted to use electrical methods. Before passing on to the subject further, it is desirable 
that the readers get themselves acquainted with the following terms much used 
in the economics of power generation : 
      (i) Interest. The cost of use of money is known as interest.  A power station is constructed by investing 
a huge capital. This money is generally borrowed from banks or other financial institutions and the supply 
company has to pay the annual interest on 
this amount. Even if company has spent out of its reserve funds, the interest must be still allowed for, 
since this amount could have earned interest if deposited in a bank. Therefore, while calculating the cost 
of production of electrical energy, the interest payable on the capital investment must be included. The 
rate of interest depends upon market position and other factors, and may vary from 4% to 8% per annum. 
     (ii) Depreciation. The decrease in the value of the power plant equipment and building due to constant 
use is known as depreciation. If the power station equipment were to last for ever, then interest on the 
capital investment would have been the only charge to be made. However, in actual practice, every 
power station has a useful life ranging from fifty to sixty years. From the time the power station is 
installed, its equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in 
the value of the plant. This reduction in the value of plant every year is known as annual depreciation. 
Due to depreciation, the plant has to be replaced by the new one after its useful life. Therefore, suitable 
amount must be set aside every year so that by the time the plant retires, the collected amount by way of 
depreciation equals the cost of replacement. It becomes obvious that while determining the cost of 
production, annual depreciation charges must be included.  
Cost of Electrical Energy 
The total cost of electrical energy generated can be divided into three parts, namely; 
(i) Fixed cost ; 
(ii) Semi-fixed cost ; 
(iii) Running or operating cost. 
       (i) Fixed cost. It is the cost which is independent of maximum demand and units generated. The fixed 
cost is due to the annual cost of central organization, interest on capital cost of land and salaries of high 
officials. The annual expenditure on the central organisation and salaries of high officials is fixed since it 
has to be met whether the plant has high or low maximum demand or it generates less or more units. 
Further, the capital investment on the land is fixed and hence the amount of interest is also fixed. 
      (ii) Semi-fixed cost. It is the cost which depends upon maximum demand but is independent of units 
generated. The semifixed cost is directly proportional to the maximum demand on power station and is 
on account of annual interest and depreciation on capital investment of building and equipment, taxes, 
salaries of management and clerical staff. The maximum demand on the power station determines its size 
and cost of installation. The greater the maximum demand on a power station, the greater is its size and 
cost of installation. Further, the taxes and clerical staff depend upon the size of the plant and hence upon 
maximum demand. 
     (iii) Running cost. It is the cost which depends only upon the number of units generated. The running 
cost is on account of annual cost of fuel, lubricating oil, maintenance, repairs and salaries of operating 
staff. Since these charges depend upon the energy output, the running cost is directly proportional to the 
number of units generated by the station. In other words, if the power station generates more units, it 
will have higher running cost and vice-versa. 
Expressions for Cost of Electrical Energy The overall annual cost of electrical energy generated by a power 
station can be expressed in two forms viz three part form and two part form. 
      (i) Three part form. In this method, the overall annual cost of electrical energy generated is divided 
into three parts viz fixed cost, semi-fixed cost and running cost i.e. 
         Total annual cost of energy = Fixed cost + Semi-fixed cost + Running cost 
                                        = Constant + Proportional to max. demand + Proportional to 
                                           kWh generated. 
                                        = Rs (a + b kW + c kWh) 
Where a = annual fixed cost independent of maximum demand and energy output.  
                                    b = constant which when multiplied by maximum kW demand on the station gives the 
annual semi-fixed cost. 
                                     c = a constant which when multiplied by kWh output per annum  gives the annual 
running cost. 
     (ii) Two part form. It is sometimes convenient to give the annual cost of energy in two part form. In 
this case, the annual cost of energy is divided into two parts viz., a fixed sum per kW of maximum demand 
plus a running charge per unit of energy. The expression for the           annual cost of energy then 
becomes: 
         Total annual cost of energy = Rs. (A kW + B kWh) 
Where A = a constant which when multiplied by maximum kW demand on the station gives the annual 
cost of the first part. 
Page 3


  
 
Economics of Power Generation 
The art of determining the per unit (i.e., one kWh) cost of production of electrical energy is known as 
economics of power generation. 
     The economics of power generation has assumed a great importance in this fast developing power 
plant engineering. A consumer will use electric power only if it is supplied at reasonable rate. Therefore, 
power engineers have to find convenient methods to produce electric power as cheap as possible so that 
consumers are tempted to use electrical methods. Before passing on to the subject further, it is desirable 
that the readers get themselves acquainted with the following terms much used 
in the economics of power generation : 
      (i) Interest. The cost of use of money is known as interest.  A power station is constructed by investing 
a huge capital. This money is generally borrowed from banks or other financial institutions and the supply 
company has to pay the annual interest on 
this amount. Even if company has spent out of its reserve funds, the interest must be still allowed for, 
since this amount could have earned interest if deposited in a bank. Therefore, while calculating the cost 
of production of electrical energy, the interest payable on the capital investment must be included. The 
rate of interest depends upon market position and other factors, and may vary from 4% to 8% per annum. 
     (ii) Depreciation. The decrease in the value of the power plant equipment and building due to constant 
use is known as depreciation. If the power station equipment were to last for ever, then interest on the 
capital investment would have been the only charge to be made. However, in actual practice, every 
power station has a useful life ranging from fifty to sixty years. From the time the power station is 
installed, its equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in 
the value of the plant. This reduction in the value of plant every year is known as annual depreciation. 
Due to depreciation, the plant has to be replaced by the new one after its useful life. Therefore, suitable 
amount must be set aside every year so that by the time the plant retires, the collected amount by way of 
depreciation equals the cost of replacement. It becomes obvious that while determining the cost of 
production, annual depreciation charges must be included.  
Cost of Electrical Energy 
The total cost of electrical energy generated can be divided into three parts, namely; 
(i) Fixed cost ; 
(ii) Semi-fixed cost ; 
(iii) Running or operating cost. 
       (i) Fixed cost. It is the cost which is independent of maximum demand and units generated. The fixed 
cost is due to the annual cost of central organization, interest on capital cost of land and salaries of high 
officials. The annual expenditure on the central organisation and salaries of high officials is fixed since it 
has to be met whether the plant has high or low maximum demand or it generates less or more units. 
Further, the capital investment on the land is fixed and hence the amount of interest is also fixed. 
      (ii) Semi-fixed cost. It is the cost which depends upon maximum demand but is independent of units 
generated. The semifixed cost is directly proportional to the maximum demand on power station and is 
on account of annual interest and depreciation on capital investment of building and equipment, taxes, 
salaries of management and clerical staff. The maximum demand on the power station determines its size 
and cost of installation. The greater the maximum demand on a power station, the greater is its size and 
cost of installation. Further, the taxes and clerical staff depend upon the size of the plant and hence upon 
maximum demand. 
     (iii) Running cost. It is the cost which depends only upon the number of units generated. The running 
cost is on account of annual cost of fuel, lubricating oil, maintenance, repairs and salaries of operating 
staff. Since these charges depend upon the energy output, the running cost is directly proportional to the 
number of units generated by the station. In other words, if the power station generates more units, it 
will have higher running cost and vice-versa. 
Expressions for Cost of Electrical Energy The overall annual cost of electrical energy generated by a power 
station can be expressed in two forms viz three part form and two part form. 
      (i) Three part form. In this method, the overall annual cost of electrical energy generated is divided 
into three parts viz fixed cost, semi-fixed cost and running cost i.e. 
         Total annual cost of energy = Fixed cost + Semi-fixed cost + Running cost 
                                        = Constant + Proportional to max. demand + Proportional to 
                                           kWh generated. 
                                        = Rs (a + b kW + c kWh) 
Where a = annual fixed cost independent of maximum demand and energy output.  
                                    b = constant which when multiplied by maximum kW demand on the station gives the 
annual semi-fixed cost. 
                                     c = a constant which when multiplied by kWh output per annum  gives the annual 
running cost. 
     (ii) Two part form. It is sometimes convenient to give the annual cost of energy in two part form. In 
this case, the annual cost of energy is divided into two parts viz., a fixed sum per kW of maximum demand 
plus a running charge per unit of energy. The expression for the           annual cost of energy then 
becomes: 
         Total annual cost of energy = Rs. (A kW + B kWh) 
Where A = a constant which when multiplied by maximum kW demand on the station gives the annual 
cost of the first part. 
               B = a constant which when multiplied by the annual kWh generated gives the annual running 
cost. 
     It is interesting to see here that two-part form is a simplification of three-part form. A little reflection 
shows that constant “a” of the three part form has been merged in fixed sum per kW maximum demand 
(i.e. constant A ) in the two-part form. 
 
Importance of High Load Factor The load factor plays a vital role in determining the cost of energy. Some 
important advantages of high load factor are listed below: 
     (i) Reduces cost per unit generated: A high load factor reduces the overall cost per unit generated. The 
higher the load factor, the lower is the generation cost. It is because higher load factor means that for a 
given maximum demand, the number of units generated is more. This reduces the cost of generation. 
    (ii) Reduces variable load problems: A high load factor reduces the variable load problems on the power 
station. A higher load factor means comparatively less variations in the load demands at various times. 
This avoids the frequent use of regulating devices installed to meet the variable load on the station. 
Tariff 
The rate at which electrical energy is supplied to a consumer is known as tariff. 
     Although tariff should include the total cost of producing and supplying electrical energy plus the 
profit, yet it cannot be the same for all types of consumers. It is because the cost of producing electrical 
energy depends to a considerable extent upon the magnitude of electrical energy consumed by the user 
and his load conditions. Therefore, in all fairness, due consideration has to be given to different types of 
consumers (e.g., industrial, domestic and commercial) while fixing the tariff. This makes the problem of 
suitable rate making highly complicated. 
      Objectives of tariff: Like other commodities, electrical energy is also sold at such a rate so that it not 
only returns the cost but also earns reasonable profit. Therefore, a tariff should include the following 
items: 
      (i) Recovery of cost of producing electrical energy at the power station. 
     (ii) Recovery of cost on the capital investment in transmission and distribution systems. 
    (iii) Recovery of cost of operation and maintenance of supply of electrical energy e.g., metering 
equipment, billing etc. 
     (iv) A suitable profit on the capital investment.  
Desirable Characteristics of a Tariff 
A tariff must have the following desirable characteristics: 
     (i) Proper return: The tariff should be such that it ensures the proper return from each consumer. In 
other words, the total receipts from the consumers must be equal to the cost of producing and supplying 
electrical energy plus reasonable profit. This will enable the electric supply company to ensure continuous 
Page 4


  
 
Economics of Power Generation 
The art of determining the per unit (i.e., one kWh) cost of production of electrical energy is known as 
economics of power generation. 
     The economics of power generation has assumed a great importance in this fast developing power 
plant engineering. A consumer will use electric power only if it is supplied at reasonable rate. Therefore, 
power engineers have to find convenient methods to produce electric power as cheap as possible so that 
consumers are tempted to use electrical methods. Before passing on to the subject further, it is desirable 
that the readers get themselves acquainted with the following terms much used 
in the economics of power generation : 
      (i) Interest. The cost of use of money is known as interest.  A power station is constructed by investing 
a huge capital. This money is generally borrowed from banks or other financial institutions and the supply 
company has to pay the annual interest on 
this amount. Even if company has spent out of its reserve funds, the interest must be still allowed for, 
since this amount could have earned interest if deposited in a bank. Therefore, while calculating the cost 
of production of electrical energy, the interest payable on the capital investment must be included. The 
rate of interest depends upon market position and other factors, and may vary from 4% to 8% per annum. 
     (ii) Depreciation. The decrease in the value of the power plant equipment and building due to constant 
use is known as depreciation. If the power station equipment were to last for ever, then interest on the 
capital investment would have been the only charge to be made. However, in actual practice, every 
power station has a useful life ranging from fifty to sixty years. From the time the power station is 
installed, its equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in 
the value of the plant. This reduction in the value of plant every year is known as annual depreciation. 
Due to depreciation, the plant has to be replaced by the new one after its useful life. Therefore, suitable 
amount must be set aside every year so that by the time the plant retires, the collected amount by way of 
depreciation equals the cost of replacement. It becomes obvious that while determining the cost of 
production, annual depreciation charges must be included.  
Cost of Electrical Energy 
The total cost of electrical energy generated can be divided into three parts, namely; 
(i) Fixed cost ; 
(ii) Semi-fixed cost ; 
(iii) Running or operating cost. 
       (i) Fixed cost. It is the cost which is independent of maximum demand and units generated. The fixed 
cost is due to the annual cost of central organization, interest on capital cost of land and salaries of high 
officials. The annual expenditure on the central organisation and salaries of high officials is fixed since it 
has to be met whether the plant has high or low maximum demand or it generates less or more units. 
Further, the capital investment on the land is fixed and hence the amount of interest is also fixed. 
      (ii) Semi-fixed cost. It is the cost which depends upon maximum demand but is independent of units 
generated. The semifixed cost is directly proportional to the maximum demand on power station and is 
on account of annual interest and depreciation on capital investment of building and equipment, taxes, 
salaries of management and clerical staff. The maximum demand on the power station determines its size 
and cost of installation. The greater the maximum demand on a power station, the greater is its size and 
cost of installation. Further, the taxes and clerical staff depend upon the size of the plant and hence upon 
maximum demand. 
     (iii) Running cost. It is the cost which depends only upon the number of units generated. The running 
cost is on account of annual cost of fuel, lubricating oil, maintenance, repairs and salaries of operating 
staff. Since these charges depend upon the energy output, the running cost is directly proportional to the 
number of units generated by the station. In other words, if the power station generates more units, it 
will have higher running cost and vice-versa. 
Expressions for Cost of Electrical Energy The overall annual cost of electrical energy generated by a power 
station can be expressed in two forms viz three part form and two part form. 
      (i) Three part form. In this method, the overall annual cost of electrical energy generated is divided 
into three parts viz fixed cost, semi-fixed cost and running cost i.e. 
         Total annual cost of energy = Fixed cost + Semi-fixed cost + Running cost 
                                        = Constant + Proportional to max. demand + Proportional to 
                                           kWh generated. 
                                        = Rs (a + b kW + c kWh) 
Where a = annual fixed cost independent of maximum demand and energy output.  
                                    b = constant which when multiplied by maximum kW demand on the station gives the 
annual semi-fixed cost. 
                                     c = a constant which when multiplied by kWh output per annum  gives the annual 
running cost. 
     (ii) Two part form. It is sometimes convenient to give the annual cost of energy in two part form. In 
this case, the annual cost of energy is divided into two parts viz., a fixed sum per kW of maximum demand 
plus a running charge per unit of energy. The expression for the           annual cost of energy then 
becomes: 
         Total annual cost of energy = Rs. (A kW + B kWh) 
Where A = a constant which when multiplied by maximum kW demand on the station gives the annual 
cost of the first part. 
               B = a constant which when multiplied by the annual kWh generated gives the annual running 
cost. 
     It is interesting to see here that two-part form is a simplification of three-part form. A little reflection 
shows that constant “a” of the three part form has been merged in fixed sum per kW maximum demand 
(i.e. constant A ) in the two-part form. 
 
Importance of High Load Factor The load factor plays a vital role in determining the cost of energy. Some 
important advantages of high load factor are listed below: 
     (i) Reduces cost per unit generated: A high load factor reduces the overall cost per unit generated. The 
higher the load factor, the lower is the generation cost. It is because higher load factor means that for a 
given maximum demand, the number of units generated is more. This reduces the cost of generation. 
    (ii) Reduces variable load problems: A high load factor reduces the variable load problems on the power 
station. A higher load factor means comparatively less variations in the load demands at various times. 
This avoids the frequent use of regulating devices installed to meet the variable load on the station. 
Tariff 
The rate at which electrical energy is supplied to a consumer is known as tariff. 
     Although tariff should include the total cost of producing and supplying electrical energy plus the 
profit, yet it cannot be the same for all types of consumers. It is because the cost of producing electrical 
energy depends to a considerable extent upon the magnitude of electrical energy consumed by the user 
and his load conditions. Therefore, in all fairness, due consideration has to be given to different types of 
consumers (e.g., industrial, domestic and commercial) while fixing the tariff. This makes the problem of 
suitable rate making highly complicated. 
      Objectives of tariff: Like other commodities, electrical energy is also sold at such a rate so that it not 
only returns the cost but also earns reasonable profit. Therefore, a tariff should include the following 
items: 
      (i) Recovery of cost of producing electrical energy at the power station. 
     (ii) Recovery of cost on the capital investment in transmission and distribution systems. 
    (iii) Recovery of cost of operation and maintenance of supply of electrical energy e.g., metering 
equipment, billing etc. 
     (iv) A suitable profit on the capital investment.  
Desirable Characteristics of a Tariff 
A tariff must have the following desirable characteristics: 
     (i) Proper return: The tariff should be such that it ensures the proper return from each consumer. In 
other words, the total receipts from the consumers must be equal to the cost of producing and supplying 
electrical energy plus reasonable profit. This will enable the electric supply company to ensure continuous 
and reliable service to the consumers. 
    (ii) Fairness: The tariff must be fair so that different types of consumers are satisfied with the rate of 
charge of electrical energy. Thus a big consumer should be charged at a lower rate than a small consumer. 
It is because increased energy consumption spreads the fixed charges over a greater number of units, 
thus reducing the overall cost of producing electrical energy.  
          Similarly, a consumer whose load conditions do not deviate much from the ideal (i.e., non- variable) 
should be charged at a lower* rate than the one whose load conditions change appreciably from the 
ideal. 
   (iii) Simplicity : The tariff should be simple so that an ordinary consumer can easily understand it. A 
complicated tariff may cause an opposition from the public which is generally distrustful of supply 
companies. 
    (iv) Reasonable profit: The profit element in the tariff should be reasonable. An electric supply 
company is a public utility company and generally enjoys the benefits of monopoly. There fore, the 
investment is relatively safe due to non-competition in the market. This calls for the profit to be restricted 
to 8% or so per annum. 
     (v) Attractive: The tariff should be attractive so that a large number of consumers are encouraged to 
use electrical energy. Efforts should be made to fix the tariff in such a way so that consumers can pay 
easily. 
Types of Tariff 
There are several types of tariff. However, the following are the commonly used types of tariff: 
     1. Simple tariff. When there is a fixed rate per unit of energy consumed, it is called a simple tariff or 
uniform rate tariff. 
     In this type of tariff, the price charged per unit is constant i.e., it does not vary with increase or 
decrease in number of units consumed. The consumption of electrical energy at the consumer’s terminals 
is recorded by means of an energy meter. This is the simplest of all tariffs and is readily understood by the 
consumers. 
Disadvantages 
      (i) There is no discrimination between different types of consumers since every consumer has  to pay 
equitably for the fixed charges. 
     (ii) The cost per unit delivered is high. 
    (iii) It does not encourage the use of electricity. 
     2. Flat rate tariff: When different types of consumers are charged at different uniform per unit rates, it 
is called a flat rate tariff. 
     In this type of tariff, the consumers are grouped into different classes and each class of consumers is 
charged at a different uniform rate. For instance, the flat rate per kWh for lighting load may be 60 paise, 
Page 5


  
 
Economics of Power Generation 
The art of determining the per unit (i.e., one kWh) cost of production of electrical energy is known as 
economics of power generation. 
     The economics of power generation has assumed a great importance in this fast developing power 
plant engineering. A consumer will use electric power only if it is supplied at reasonable rate. Therefore, 
power engineers have to find convenient methods to produce electric power as cheap as possible so that 
consumers are tempted to use electrical methods. Before passing on to the subject further, it is desirable 
that the readers get themselves acquainted with the following terms much used 
in the economics of power generation : 
      (i) Interest. The cost of use of money is known as interest.  A power station is constructed by investing 
a huge capital. This money is generally borrowed from banks or other financial institutions and the supply 
company has to pay the annual interest on 
this amount. Even if company has spent out of its reserve funds, the interest must be still allowed for, 
since this amount could have earned interest if deposited in a bank. Therefore, while calculating the cost 
of production of electrical energy, the interest payable on the capital investment must be included. The 
rate of interest depends upon market position and other factors, and may vary from 4% to 8% per annum. 
     (ii) Depreciation. The decrease in the value of the power plant equipment and building due to constant 
use is known as depreciation. If the power station equipment were to last for ever, then interest on the 
capital investment would have been the only charge to be made. However, in actual practice, every 
power station has a useful life ranging from fifty to sixty years. From the time the power station is 
installed, its equipment steadily deteriorates due to wear and tear so that there is a gradual reduction in 
the value of the plant. This reduction in the value of plant every year is known as annual depreciation. 
Due to depreciation, the plant has to be replaced by the new one after its useful life. Therefore, suitable 
amount must be set aside every year so that by the time the plant retires, the collected amount by way of 
depreciation equals the cost of replacement. It becomes obvious that while determining the cost of 
production, annual depreciation charges must be included.  
Cost of Electrical Energy 
The total cost of electrical energy generated can be divided into three parts, namely; 
(i) Fixed cost ; 
(ii) Semi-fixed cost ; 
(iii) Running or operating cost. 
       (i) Fixed cost. It is the cost which is independent of maximum demand and units generated. The fixed 
cost is due to the annual cost of central organization, interest on capital cost of land and salaries of high 
officials. The annual expenditure on the central organisation and salaries of high officials is fixed since it 
has to be met whether the plant has high or low maximum demand or it generates less or more units. 
Further, the capital investment on the land is fixed and hence the amount of interest is also fixed. 
      (ii) Semi-fixed cost. It is the cost which depends upon maximum demand but is independent of units 
generated. The semifixed cost is directly proportional to the maximum demand on power station and is 
on account of annual interest and depreciation on capital investment of building and equipment, taxes, 
salaries of management and clerical staff. The maximum demand on the power station determines its size 
and cost of installation. The greater the maximum demand on a power station, the greater is its size and 
cost of installation. Further, the taxes and clerical staff depend upon the size of the plant and hence upon 
maximum demand. 
     (iii) Running cost. It is the cost which depends only upon the number of units generated. The running 
cost is on account of annual cost of fuel, lubricating oil, maintenance, repairs and salaries of operating 
staff. Since these charges depend upon the energy output, the running cost is directly proportional to the 
number of units generated by the station. In other words, if the power station generates more units, it 
will have higher running cost and vice-versa. 
Expressions for Cost of Electrical Energy The overall annual cost of electrical energy generated by a power 
station can be expressed in two forms viz three part form and two part form. 
      (i) Three part form. In this method, the overall annual cost of electrical energy generated is divided 
into three parts viz fixed cost, semi-fixed cost and running cost i.e. 
         Total annual cost of energy = Fixed cost + Semi-fixed cost + Running cost 
                                        = Constant + Proportional to max. demand + Proportional to 
                                           kWh generated. 
                                        = Rs (a + b kW + c kWh) 
Where a = annual fixed cost independent of maximum demand and energy output.  
                                    b = constant which when multiplied by maximum kW demand on the station gives the 
annual semi-fixed cost. 
                                     c = a constant which when multiplied by kWh output per annum  gives the annual 
running cost. 
     (ii) Two part form. It is sometimes convenient to give the annual cost of energy in two part form. In 
this case, the annual cost of energy is divided into two parts viz., a fixed sum per kW of maximum demand 
plus a running charge per unit of energy. The expression for the           annual cost of energy then 
becomes: 
         Total annual cost of energy = Rs. (A kW + B kWh) 
Where A = a constant which when multiplied by maximum kW demand on the station gives the annual 
cost of the first part. 
               B = a constant which when multiplied by the annual kWh generated gives the annual running 
cost. 
     It is interesting to see here that two-part form is a simplification of three-part form. A little reflection 
shows that constant “a” of the three part form has been merged in fixed sum per kW maximum demand 
(i.e. constant A ) in the two-part form. 
 
Importance of High Load Factor The load factor plays a vital role in determining the cost of energy. Some 
important advantages of high load factor are listed below: 
     (i) Reduces cost per unit generated: A high load factor reduces the overall cost per unit generated. The 
higher the load factor, the lower is the generation cost. It is because higher load factor means that for a 
given maximum demand, the number of units generated is more. This reduces the cost of generation. 
    (ii) Reduces variable load problems: A high load factor reduces the variable load problems on the power 
station. A higher load factor means comparatively less variations in the load demands at various times. 
This avoids the frequent use of regulating devices installed to meet the variable load on the station. 
Tariff 
The rate at which electrical energy is supplied to a consumer is known as tariff. 
     Although tariff should include the total cost of producing and supplying electrical energy plus the 
profit, yet it cannot be the same for all types of consumers. It is because the cost of producing electrical 
energy depends to a considerable extent upon the magnitude of electrical energy consumed by the user 
and his load conditions. Therefore, in all fairness, due consideration has to be given to different types of 
consumers (e.g., industrial, domestic and commercial) while fixing the tariff. This makes the problem of 
suitable rate making highly complicated. 
      Objectives of tariff: Like other commodities, electrical energy is also sold at such a rate so that it not 
only returns the cost but also earns reasonable profit. Therefore, a tariff should include the following 
items: 
      (i) Recovery of cost of producing electrical energy at the power station. 
     (ii) Recovery of cost on the capital investment in transmission and distribution systems. 
    (iii) Recovery of cost of operation and maintenance of supply of electrical energy e.g., metering 
equipment, billing etc. 
     (iv) A suitable profit on the capital investment.  
Desirable Characteristics of a Tariff 
A tariff must have the following desirable characteristics: 
     (i) Proper return: The tariff should be such that it ensures the proper return from each consumer. In 
other words, the total receipts from the consumers must be equal to the cost of producing and supplying 
electrical energy plus reasonable profit. This will enable the electric supply company to ensure continuous 
and reliable service to the consumers. 
    (ii) Fairness: The tariff must be fair so that different types of consumers are satisfied with the rate of 
charge of electrical energy. Thus a big consumer should be charged at a lower rate than a small consumer. 
It is because increased energy consumption spreads the fixed charges over a greater number of units, 
thus reducing the overall cost of producing electrical energy.  
          Similarly, a consumer whose load conditions do not deviate much from the ideal (i.e., non- variable) 
should be charged at a lower* rate than the one whose load conditions change appreciably from the 
ideal. 
   (iii) Simplicity : The tariff should be simple so that an ordinary consumer can easily understand it. A 
complicated tariff may cause an opposition from the public which is generally distrustful of supply 
companies. 
    (iv) Reasonable profit: The profit element in the tariff should be reasonable. An electric supply 
company is a public utility company and generally enjoys the benefits of monopoly. There fore, the 
investment is relatively safe due to non-competition in the market. This calls for the profit to be restricted 
to 8% or so per annum. 
     (v) Attractive: The tariff should be attractive so that a large number of consumers are encouraged to 
use electrical energy. Efforts should be made to fix the tariff in such a way so that consumers can pay 
easily. 
Types of Tariff 
There are several types of tariff. However, the following are the commonly used types of tariff: 
     1. Simple tariff. When there is a fixed rate per unit of energy consumed, it is called a simple tariff or 
uniform rate tariff. 
     In this type of tariff, the price charged per unit is constant i.e., it does not vary with increase or 
decrease in number of units consumed. The consumption of electrical energy at the consumer’s terminals 
is recorded by means of an energy meter. This is the simplest of all tariffs and is readily understood by the 
consumers. 
Disadvantages 
      (i) There is no discrimination between different types of consumers since every consumer has  to pay 
equitably for the fixed charges. 
     (ii) The cost per unit delivered is high. 
    (iii) It does not encourage the use of electricity. 
     2. Flat rate tariff: When different types of consumers are charged at different uniform per unit rates, it 
is called a flat rate tariff. 
     In this type of tariff, the consumers are grouped into different classes and each class of consumers is 
charged at a different uniform rate. For instance, the flat rate per kWh for lighting load may be 60 paise, 
whereas it may be slightly less (say 55 paise per kWh) for power load. The different classes of consumers 
are made taking into account their diversity and load factors. The advantage of such a tariff is that it is 
more fair to different types of consumers and is quite simple in calculations. 
Disadvantages 
      (i) Since the flat rate tariff varies according to the way the supply is used, separate meters are required 
for lighting load, power load etc. This makes the application of such a tariff expensive and complicated. 
     (ii) A particular class of consumers is charged at the same rate irrespective of the magnitude of energy 
consumed. However, a big consumer should be charged at a lower rate as in his case the fixed charges per 
unit are reduced. 
     3. Block rate tariff. When a given block of energy is charged at a specified rate and the succeeding 
blocks of energy are charged at progressively reduced rates, it is called a block rate tariff. 
     In block rate tariff, the energy consumption is divided into blocks and the price per unit is fixed in each 
block. The price per unit in the first block is the highest** and it is progressively reduced for the 
succeeding blocks of energy. For example, the first 30 units may be charged at the rate of 60 paise per 
unit; the next 25 units at the rate of 55 paise per unit and the remaining additional units may be charged 
at the rate of 30 paise per unit. 
     The advantage of such a tariff is that the consumer gets an incentive to consume more electrical 
energy. This increases the load factor of the system and hence the cost of generation is reduced. 
However, its principal defect is that it lacks a measure of the consumer’s demand. This type of tariff is 
being used for majority of residential and small commercial consumers.  
     4. Two-part tariff. When the rate of electrical energy is charged on the basis of maximum demand of 
the consumer and the units consumed, it is called a two-part tariff. 
     In two-part tariff, the total charge to be made from the consumer is split into two components viz., 
fixed charges and running charges. The fixed charges depend upon the maximum demand of the 
consumer while the running charges depend upon the number of units consumed by the consumer. Thus, 
the consumer is charged at a certain amount per kW of maximum†† demand plus a certain amount per 
kWh of energy consumed i.e., 
Total charges = Rs (b kW + c kWh) 
where,    b = charge per kW of maximum demand 
                                      c = charge per kWh of energy consumed 
     This type of tariff is mostly applicable to industrial consumers who have appreciable maximum 
demand. 
Advantages 
      (i) It is easily understood by the consumers. 
     (ii) It recovers the fixed charges which depend upon the maximum demand of the consumer but are